Non-Qualified Personal Residence Trusts

What is a Non-Qualified Personal Residence Trust (Non-QPRTs)?

While a Qualified Personal Residence Trust(QPRT) has many potential benefits, it also has some glaring drawbacks; namely, if the grantor dies before their right to live in the home taxfree expires, they will be worse-off, from an estate-tax standpoint, than if they had not used a QPRT at all. Furthermore, the QPRT’s asset protection benefits are questionable at best.

How then might one overcome a QPRT’s asset protection and potential tax shortcomings? One way is to use a non-QPRT (also referred to as an NQPRT). A non-QPRT is a trust that holds a home while not being qualified for estate tax savings under IRC §2702. Nonetheless, estate tax savings may still be realized, although not in the same way as with a QPRT.

A non-QPRT is a non-self-settled, irrevocable grantor trust that buys the home (a self-settled trust is a trust where a grantor is also a beneficiary; most states do not allow such trusts to protect assets from the grantor’s creditors).

Trust assets are not included in the seller’s estate. Simply put, the trust gives the seller a self-canceling installment note (SCIN) in exchange for his home. As we discussed in the chapter on trust fundamentals, an SCIN is a promissory note to pay a debt in regular installments, however if the note-holder dies, then the note is cancelled and the trust owes no further payments; the home is now owned free and clear by the trust. As long as the promissory note’s value is equivalent to the fair market value of the home, the transfer of the home to the trust in exchange for the SCIN is an exchange of equivalent value and thus the transfer is much less likely to be considered fraudulent.

After the transfer, the seller pays fair market value rent to the NQPRT for his continued use of the home, which the NQPRT in turn uses to make payments on the SCIN. After the fraudulent transfer statute of limitations expires, one may safely engage in more aggressive estate tax savings, if desired, by forgiving up to $26,000 in note payments per year as a split gift between husband and wife. Thus, rent payments are made to the trust, which reduces the seller’s taxable estate, and the trust can keep more of those payments from going back to the seller since it now pays less (or nothing) on the SCIN. When the seller dies, the home and any rent payments that have accumulated in the trust are not included in his gross estate. Trust property instead passes to his heirs, who are residual beneficiaries of the trust.

The NQPRT is a stronger asset protection tool than the QPRT because the home is transferred to the trust in exchange for something of equivalent value (the SCIN), and furthermore the transferor does not live in the home rent free. There is also less risk with a NQPRT from an estate tax perspective, since there is no term of years the transferor must survive in order to make sure the trust reduces estate tax liability.

A NQPRT is often a more effective tool than a QPRT, but it may not be a good idea for anyone who only wishes to protect their home. Remember, a NQPRT is an irrevocable trust, meaning once you make the transfer, you can’t get the home back. For maximum asset protection, the transferor shouldn’t retain the right to direct the trustee to sell the home, purchase a new home, or distribute trust funds to the transferor (the trust may however be drafted so that the residual beneficiaries have limited powers to direct the trustee in such a manner).

A NQPRT, like the QPRT, is meant to eventually pass a home to one’s heirs. Furthermore, transferring a mortgaged home to a non-QPRT may cause problems with the mortgage holder, which means only unencumbered homes, or homes whose mortgage could be paid off, are ideal candidates for a non-QPRT unless the mortgage holder agrees to the transfer. Therefore, if the parameters of an NQPRT do not match an individual’s goals and circumstances, they should protect their home via equity stripping, which is discussed in chapter 15. Alternatively, a person could move to one of the five states that protect 100% of a homestead’s value from creditors, or perhaps use a Domestic Asset Protection Trust (DAPT) if his state of residence has passed DAPT legislation (however the authors recommend DAPTs only if none of the other strategies are feasible).